Overview of Transfer Pricing

Contents
Legislative framework

Transfer pricing study

Assessment and Litigation

Key Recent Developments

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Transfer Pricing in India- Background
April 1, 2001 onwards
Comprehensive legislation introduced in Union Budget 2001

Detailed Rules providing guidance for application of the legislation framed

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Concept of transfer pricing
Transfer Pricing refers to the pricing
of international transactions between
two associated enterprises

Due to the special relationship between related

parties, the transfer price may be different than
the price that would have been agreed
between unrelated parties

A price between unrelated parties is known

as the arms length price

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Concept
Associated Independent
enterprise entity

International transactions
- goods
- services
- intangibles
- loans

Resident Resident

Transfer price Arms length price

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Applicability
The provisions of Section 92 to 92F of the Act are applicable only if:

There are two or more enterprises (defined in Sec 92F)

The enterprises are Associated enterprises (defined in Sec 92A)

The enterprises enter into a transaction (defined in Sec 92F)

The transaction is an International transaction (defined in Sec 92B)

Provisions do not apply in certain cases (Section 92(3))

Further w.e.f. 1 April 2012, TP provisions shall also apply to specified domestic
transactions (SDT) (defined in Sec 92BA)

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Applicability
Consequences of these provisions:

Computation of income/ expenses having regard to the Arms length

price (Section 92(1))

Maintenance of prescribed Documentation (Section 92D read with Rule 10D)

Obtaining of Accountants report (under Form 3CEB) (Section 92E)

To ensure compliance with the arms length principle, stringent Penalties

have been prescribed

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Applicability
Section 92(1)

Any income (or expense or interest) arising from an

international transaction shall be computed having regard
to the arms length price

Section 92(3) -

The provisions are not intended to be applied in case

determination of arms length price reduces the income
chargeable to tax or increases the loss as the case may be

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Meaning of Associated enterprises
(Section 92A)
A Direct or indirect participation
(through one or more
intermediaries) in
B Both A and B management, control or capital
are associated
enterprises of C
C

A D
D and E are also
associated
B E enterprises of C
since they have a
common ultimate
C parent (A)

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Deemed Associated enterprises (Section
92A(2)
Equity Holding Management Activities Control

1. >= 26% direct / 6. Appointment > 8. 100% 11. One enterprise

indirect holding 50% of dependence on controlled by an

by enterprise Directors / one use of individual and
or more intangibles for the other by
OR Executive manufacture / himself or his
Director by an processing / relative or jointly
2. By same enterprise business
person in each 12. One enterprise
enterprise OR 9. Direct / indirect controlled by
supply of > = 90% HUF and the
3. Loan >= 51% of 7. Appointment Raw Materials other by
Total Assets by same under influenced - a member of HUF
person in each prices and - his relative or
4. Guarantees > = enterprise conditions - Jointly by member
10% of debt 10. Sale under and relative

5. > 10% interest influenced

in Firm / AOP / prices and
BOI conditions

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International transaction (Section 92B)
Transactions between two or more associated enterprises
Either or both of whom are non-residents
Transaction relates to:
purchase, sale or lease of tangible or intangible property; or
provision of services; or
lending or borrowing money; or
any other transaction having a bearing on the profits, income, losses or assets of
the enterprises; or
mutual agreements or arrangements for allocation or apportionment of, or any
contribution to, any cost or expense incurred
Scope expanded in Finance Act, 2012 to include - intangibles like marketing
intangibles, human capital, Business restructuring, inter-company guarantees, capital
funding, etc.

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Deemed international transaction Sec 92B(2)
Transactions with non-group companies deemed to be international
transactions subject to transfer pricing regulations
Prior agreement

As Parent 3rd party Transaction between A and 3rd party

also subject to transfer pricing norms, if:
a prior agreement exists between
rd
As parent and 3 party (both non-
residents) in relation to services
A rd
rendered by A to the 3 party; or
terms of transaction are
Determination of terms determined in substance by As
parent and 3rd party
As Parent 3rd party

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Specified Domestic Transactions (SDT)
Scope of transfer pricing provisions
expanded (effective FY 2012-13 and onwards)
Applicable to specified domestic transactions if aggregate value of such
transactions exceeds INR 5 crores
Transactions that could be impacted include
Transfer of goods/services between related domestic companies wherein
either of them is eligible for tax holiday benefit
Transfer of goods / services between tax holiday eligible business / units and
other businesses / units of the taxpayer in India
Payments made to persons specified u/s 40A(2)(b) [definition amended]
All provisions applicable for determination of ALP for international transactions would
apply in case of SDT also. Also penal provisions applicable to international
transactions would apply to SDT

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Which ones of these entities are associated
enterprises of ABC India?

XYZ, Japan
100%
100%

ABC, Japan XYZ, Taiwan

74%

ABC India

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Arms length price
Price applied or proposed to be applied in a transaction between persons other than
associated enterprises, in uncontrolled conditions

Determination of arms length prices using one of the Prescribed methods

Yes Whether you No

arrive at a
single price ?
The arithmetic mean of such
prices which varies from
The price thus determined transfer price (not exceeding
is the arms length price 3% (upper ceiling)
is the arms length price
(92C(2))

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The Arms Length Range - How it works
In most cases, it is not possible to identify a
single price that can be considered to be an
uncontrolled price.
It may be that a number of different
comparables are equally comparable. Several
comparable transactions can therefore define
an arms length range of possible transfer
prices
Overall range may contain extremes. Indian
legislation recognizes only arithmetic mean
(with a +/-5% variation) though statistically
and internationally an inter-quartile range may
be more appropriate.
If transfer price falls within a +/- 5% range,
pricing should be defendable as arms length
from tax authority audit perspective

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Prescribed methods

Transfer Pricing Methods

Traditional Transaction Methods Transactional Profit Methods

Other Method

Comparable Resale Price Cost Plus Profit Split Transactional

Uncontrolled Method Method Method Net Margin
Price Method

Tax payer may apply any of the above methods that is considered most
appropriate for a transaction

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Comparables
All methods require comparables
Transfer price is set/ defended using data
from comparable companies
Comparable company should be independent
and similar to an associated enterprise.
Following factors are generally used in
judging comparability (Rule 10C(2)):
nature of transactions undertaken (i.e. type of
good, service etc.)
company functions
risks assumed
contractual terms (i.e. similar credit terms)
economic and market conditions

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Comparable Uncontrolled Price Method -Rule
10B(1)(a)
Compares the price charged in a controlled
transaction with the price in an uncontrolled
transaction

Requires strict comparability in products,

contractual terms, economic terms, etc

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Comparable Uncontrolled Price Method

Identification of price charged or paid in comparable transaction(s)

Such price adjusted to account for differences if any between international transaction
and uncontrolled transaction(s)

Adjusted price arrived above taken to be arms length price

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Comparable Uncontrolled Price Method
Internal CUP

Related party - B

Manufacturer A

Non-related party

External CUP

Non-related party A Non-related party B

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Resale Price Method- Rule 10B(1)(b)
Compares the resale gross margin earned by associated enterprise with the resale gross
margin earned by comparable independent distributors
An arms length gross margin should be sufficient for a reseller to cover its operating
expenses and make an appropriate operating profit (in light of its functions and risks)
Preferred method for a distributor buying purely finished goods from a group company
without any value addition (if no CUP available)

Group Manufacturer $75 Related Distributor $100 Unrelated

(Hong Kong) (India) Distributors

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Resale Price Method
Identification of resale price by tested party

Resale price reduced by normal gross profit with reference to uncontrolled transaction(s)

Such price reduced by expenses incurred (customs duty etc.) in purchase of

the product/ services.

This price may be adjusted to account for functional and other differences if any

Adjusted price arrived above taken to be arms length price

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Cost Plus Method Rule 10B(1)(c)
Compares the gross profit on costs the associated enterprise earns with the gross
profit on costs earned by comparable independent companies
Preferred method for:
manufacturer supplying semi-finished goods
company providing services

Manufacturer A Cost + 40% Related

(Indian) Manufacturer US Market
B (US)

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Cost Plus Method

Identification of direct and indirect costs of production incurred in tested party transactions

Identification of normal gross profit with reference to uncontrolled transaction(s)

Normal gross profit adjusted to account for functional and other differences if any

Adjusted gross profit added to total costs identified in step 1

Sum arrived above is taken to be arms length price

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Profit Split Method-Rule 10B(1)(d)
Appropriate for transactions which are not capable of being evaluated separately
Calculates the combined operating profit resulting from a whole
inter-company transaction based on the relative value of each associated
enterprise's contribution to the operating profit
The contribution made by each party is determined on the basis of a division of
functions performed, valued, if possible using external comparable data
Applicable for analyzing tangible, intangible or services issues

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Profit Split Method

Determination of combined net profit of the associated enterprises arising out

of international transaction

Evaluation of relative contributions by each enterprise on the basis of functions performed,

risks assumed and assets employed

Splitting of combined net profit amongst enterprises in proportion to

their relative contributions

Profit thus apportioned to the tested party is used to arrive at the arms length price

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Transactional Net Margin Method-Rule 10B(1)(e)
Examines net operating profit from transactions as a percentage of a certain base (can
use different bases i.e. costs, turnover, etc) in respect of similar parties
Ideally, operating margin should be compared to operating margin earned by same
enterprise on uncontrolled transaction
Can compare to comparable transactions between independent parties
Applicable for any type of transaction and often used to supplement analysis under
other methods
Most frequently used method in India, due to lack of availability of comparable
uncontrolled prices and gross margin data required for application of the
comparable uncontrolled price method/ cost plus method/ resale price method

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Transactional Net Margin Method
Computation of net profit as a percentage of a certain base realised from
the international transaction.

Computation of net profit realized by the tested party or an unrelated

enterprise in a comparable uncontrolled transaction

Net profit from uncontrolled transaction adjusted to account for differences if any

The net profit thus established is taken into account to arrive at an arms
length price for the international transaction

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Which method applies?

Pharma Company USA

Sale of tablets
100kgs at
Rs 100 per
kg 10kgs at Rs 100 per kg

Pharma Company India Third parties

Which method applies to this transaction and why?

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 Documentation-Rule 10D
Entity related Price related Transaction related

Profile of industry Transaction terms Agreements

Profile of group Functional analysis (functions, Invoices

Profile of Indian entity assets and risks) Pricing related

Economic analysis (method
Profile of associated correspondence
selection, comparable
enterprises (letters, emails etc)
benchmarking)
Forecasts, budgets, estimates

Contemporaneous documentation requirement to be maintained by November 30 of relevant Assessment Year

Documentation to be retained for 9 years from financial year
Comprehensive Documentation is not required to be maintained if the aggregate value of all international transactions does not
exceed one crore rupees

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Accountants report-Rule 10E
Obtained by every tax payer filing a return in India and having international transaction

To be filed by due date for filing return of income (30 November)

Essentially comments on the following:

whether the tax payer has maintained the transfer pricing documentation
as required by the legislation,

whether as per the transfer pricing documentation the prices of international

transactions are at arms length, and

certifies the value of the international transactions as per the books of account
and as per the transfer pricing documentation are true and correct

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TP Penalties-Section 271
Default Penalty
Post-inquiry adjustment (deemed 100-300% of tax on the adjusted amount
concealment of income)

Failure to maintain documents; report 2% of the transaction value

transactions; Maintains or furnishes
incorrect information/ documentation

Failure to furnish documents 2% of the transaction value

Failure to furnish accountants report Rs 100,000

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Reading references
OECD guidelines and commentary

Guidance note from the Institute of

Chartered Accountants

BNA daily tax and transfer pricing reports

ITS worldwide weekly updates

For international case laws

Intranet (riacheckpoint.com)

www.ibfd.org

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Our Approach to Transfer pricing
Our proposed approach for transfer pricing review will be based on the following phases
of work as described in detail below:

4 Documentation/ Accountants report

Report writing/
Accountants report

3 Economic analysis
Calculation of arms length result

Selection of Best Selection of

2 Functional analysis Method Comparables

Analysis of Functions, Risks, and Intangibles

1 Fact gathering
Mapping of international transaction Industry Analysis

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Steps in a transfer pricing study
Investigation & data collection Documentation

1 Questionnaire

Interview
2 Industry overview

Functional analysis
Economic analysis

3 Others

Assist in implementation
Litigation support

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Assessment Procedure

1 U/s 92CA the AO may refer determination

of ALP to the TPO, with prior approval of
Commissioner 2 TPO would then notify the taxpayer
to produce evidence supporting
transfer price as arms length

4 AO would proceed to compute income

of the taxpayer in conformity with
ALP determined by the TPO and pass
a draft order
3 TPO would determine ALP by passing

an order based on information

gathered from the assesse/ other
sources and intimate the AO &
taxpayer
Dispute Resolution Panel
The AO to provide draft order to assessee, TPOs order
in case any adjustment is proposed. Show cause
notice
The assessee has to file the objections AOs draft order
within 30 days of receipt of the draft order;

Directions of the DRP to be issued within Within 30 days of

9 months of the end of month draft order
forwarded to Assessee;
receipt of draft order
The directions issued by the DRP Panel are No response File Objections with
appealable in the ITAT by the Assessee.

The department can appeal against the DRP

DRP directions for objections filed after
1 July 2012.
AOs order Within 9 Months from end of the

month in which draft

order was forwarded
to Assessee
CIT(A)
DRP Order

ITAT AO Order
Appeal

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Advance Pricing Arrangement (APA) regime
Introduced with effect from 1 July 2012
Framework enables unilateral, bilateral and multilateral APAs
APA to be binding on both the taxpayer and the tax authority for a period not
exceeding five years
APA team constitution notified. Unilateral APAs to lie with APA directorate headed by
DGIT and bilateral/ multilateral APAs to be handled by the Competent Authority
Detailed process guidelines released:
APA applications have a minimum filing fee based on value of
international transaction
APA framework includes mandatory pre-filing consultation
Provisions allow rejection, amendments and withdrawal of APA applications
Provisions contain Annual Reporting norms to monitor adherence to the
terms of the APA
Roll-back not allowed
Framework do not contain firewall provisions in respect of information
shared with APA authority during negotiations

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